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China plays fast catch-up with the global ESG wave

THE environmental, social and governance (ESG) movement has swept the globe, being transformed from a luxury toy of the ethically engaged to a pillar of mainstream investment practice. Investors increasingly seek to align themselves with concern for the environment, the impact of their investments on society, and a desire to invest in companies run with transparency, paying heed to the interests of minority shareholders and in accordance with best accounting practices.

Some 25 per cent of all professionally managed assets are now invested in accordance with ESG criteria, but ESG has exerted significant influence on the global investment community for only a few years. Until recently, it had barely registered as a ripple in China, despite Beijing being a major global investor.

Most Chinese investors consider compliance with ESG guidelines to be an unacceptable compromise on returns, with the country's corporations viewing ESG as little more than a box-ticking compliance exercise. But China is now playing catch-up in the ESG stakes with speed, narrowing the gap between the government's global aspirations and the conventional mindset of its international investors and corporate boards.

China is in the process of transitioning from being the world's greatest polluter to one of its greatest environmental champions, reflecting Beijing's future-oriented frame of reference, which manifests itself in much of what the Chinese do - from five-year economic plans to the Belt and Road Initiative. From its participation in the Paris climate agreement to its leadership in solar technology and move away from near-total reliance on coal-fired power plants to a pursuit of wind power, Beijing has made a noteworthy contribution to environmental consciousness.

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China's heavy subsidisation of clean energy is starting to bear fruit as the cost of wind and solar power dips below that generated from fossil fuels - solar power became cheaper than coal-fired energy in 11 Chinese provinces this year - and bolsters China's ESG mission statement as does the burgeoning pay-off from massive investment in electric vehicle production by the likes of BYD.

The change in mindset at the corporate level is being driven both by government regulation and the internationalisation of China's capital markets.

The previous "box-ticking" approach, under which companies made voluntary ESG disclosures without fear of regulatory action for failing to comply, will become a more serious endeavour once regulations come into force next year, making ESG disclosure mandatory for 3,000 of China's listed companies and bond issuers. China presently scores 21.6 in Bloomberg's average ESG disclosure score, less than half of the top rank scorer, France. That is set to change as disclosure becomes mandatory, but also as the country aims to attract international capital.

Internationalisation is also driving the same dynamic in China's flourishing Green finance market. From zero issuance in 2015, the country became the world's largest issuer of Green bonds a year later, accounting for 26 per cent of sustainable bond issuance globally. Adhering to internationally agreed Green finance guidelines requires disciplined reporting if debt is to be placed with the growing global pool of ESG-focused investors. It is also likely that China will harmonise its sustainability guidelines with the European Union's recently published Green finance taxonomy, whereby definitions of what constitutes a sustainable use of proceeds will necessarily prod the country's Green bond issuers to adopt sustainable business practices.

This alignment of corporate behaviour with the government's mission statement chimes, given that China is the world's largest investor in renewable energy and energy efficiency, accounting for 30 per cent and 27 per cent of the global total, respectively.

BANKS JOIN THE DRIVE

China's banks are also a crucial element in the ESG dynamic - seven of the country's largest banks have signed up to the Green Investment Principles, which have been established in cooperation with the European Union - with internationalisation a key underpinning, given that these banks seek to syndicate loans within a consortium of overseas peers. Corporate China's rising cognisance of ESG and the role banks play in this dynamic was recently provided for by the signing of a US$2.1 billion sustainability loan by Cofco, China's biggest food company.

At the investor level, the mindset in China is also changing fast, linked to the rise of the country's asset management industry, which has been using the proven long-term equity outperformance of ESG-compliant companies as a selling hook. Seven Chinese asset managers signed up to the UN-supported Principles for Responsible Investment in 2018, bringing the total number of signatories in the country to 18, more than double the 2017 total. These include heavyweights such as China Life Asset Management, Harvest Fund Management, and China Southern Asset Management.

At the same time, it is anticipated that insurance and pension funds seeking to match long-term liabilities with assets will embrace ESG, as China Life Asset Management Company has, together with charitable organisations, and venture capital and private equity funds. So the Chinese government's aspirations in the ESG arena are becoming a reality as the crucial actors on the ground - companies and investors - move quickly into alignment with official thinking. This is a good example of how forward thinking, government policy, competitiveness, and a social conscience have converged to have a favourable outcome in China.

Matthew McAdam is Director of Asia-Pacific for the Principles for Responsible Investment.
Jonathan Rogers is CEO of Singapore-based consultancy Ostinato Associates.
Daniel Wagner is CEO of Country Risk Solutions and author, most recently, of China Vision.